ANALYSIS: Local government borrowing in China threatens economy

Local governments across China have borrowed billions of dollars to build bridges, apartments and shopping malls, leaving many insolvent and endangering the country’s financial system, analysts say.

While the central government in Beijing is in good financial shape — it has a relatively small budget deficit, a huge trade surplus and the world’s largest foreign exchange reserves — it is a different picture outside the capital.

Local governments had borrowed 10.7 trillion yuan (US$1.7 trillion) — 27 percent of GDP — by late 2010, according to official data, though ratings agency Moody’s believes the figure is underestimated by 3.5 trillion yuan.

Several provinces have since published reports showing their debt-to-GDP ratio was higher than the national figure.

Moody’s believes that between 8 percent and 10 percent of loans made by Chinese banks will never be recouped.

“Debt across the board is rising very quickly,” weakening the banking system, said Michael Pettis, a specialist in Chinese financial markets at Peking University. “But any attempts to slow its growth results in a rapid reduction of investment and [economic] growth.”

China’s total public debt — including the central and local governments — stands at 68 percent of GDP, well below Italy’s ratio of 120 percent or Japan’s, which stands at more than 200 percent.

However, when it comes to local authorities, the key concern is repayment.

To meet their commitments, local governments need to generate income from land sales, which is fueling unrest in the world’s second-largest economy as residents increasingly complain that land is being unlawfully seized.

Such corruption allegations have culminated in protests, such as the one in Wukan, Guangdong Province, last month, where villagers staged a revolt against authorities they said had been stealing their land for years.

Another source of income is from infrastructure projects, many of which are not profitable or legal.

Investment in highways, shopping malls and apartment buildings has been a key driver of the economy in recent years, especially since the 2008 global crisis, when Beijing ordered banks to open the credit valves to spur activity.

“Over the past couple of years, more than half of Chinese GDP has been generated by investment in fixed assets” such as factories and roads, Tsinghua University economics professor Patrick Chovanec said.

There are “things that make economic sense, but are not commercially viable” such as roads or hospitals that should have been funded by taxpayer money, he said.